Dubai's debt crisis rattled world financial markets Friday, raising concerns that some banks could further tighten lending and stall the global economic recovery.
The possible spillover effects centered on fears that international banks could suffer big losses if Dubai's investment arm defaulted on its $60 billion debt. Stock and commodity markets tumbled in New York, London and Asia as investors flocked to the U.S. dollar as a safe haven.
But earlier concerns that the crisis might trigger another financial meltdown seemed to ease after some analysts downplayed the risks for U.S. banks, which are thought to have little exposure to the Middle Eastern city-state.
U.S. stocks fell sharply but rebounded from their lows as investors concluded that the damage might be contained. The Dow Jones industrial average lost about 155 points, or roughly 1.5 percent, in a shortened trading day, and other stock averages also sank.
"I don't think the collateral damage is going to be that great," said Jeffrey Saut, chief investment strategist at Raymond James. "People will dig into this over the weekend, but I think balance sheets have healed enough to withstand a shock like this."
Still, the crisis in Dubai pointed to the vulnerability of the global economy despite signs of recovery. Last year's credit debacle left major banks with billions in losses, forcing them to reduce lending to consumers and businesses.
Access to credit has improved in recent months, but analysts said Dubai's woes could make some banks more cautious. That could further squeeze lending and weaken the recovery.
"What we need for the economic momentum to continue is for banks to feel confident about lending, and clearly what has happened in the last 48 hours is not a step in the right direction," said David Williams, banking analyst at Fox-Pitt Kelton in London.
$60 billion debt
Dubai's troubles caught investors by surprise. A year after the global slump derailed the city-state's dizzying growth, its main investment arm, Dubai World, revealed this week it was seeking at least a six-month delay on repaying its $60 billion debt. Credit agencies responded by slashing debt ratings on Dubai's state companies, saying they might consider the plan a default.
In recent years, Dubai has expanded with ambitious, eye-catching projects like the Gulf's palm-shaped islands and the world's tallest skyscraper in hopes of becoming a tourist-friendly Middle Eastern metropolis. In the process, though, the state-backed networks nicknamed Dubai Inc. have racked up $80 billion in red ink. The emirate may now need another bailout from its oil-rich neighbor Abu Dhabi, the capital of the United Arab Emirates.
In Europe, stock markets rebounded after Wall Street fell less than feared. Earlier, stock indexes in Hong Kong and South Korea tumbled 5 percent in response to the previous day's Dubai-related losses in Europe.
The Dubai crisis caused the dollar to spike higher against the euro and pound but slump against the yen, another traditional safe haven. Speculation that the Bank of Japan might intervene by buying dollars or selling yen to aid Japanese exports helped the dollar recover after it had fallen to a 14-year low against the yen.
British banks appeared to be at most risk if Dubai World can't pay its bills. London-based lenders HSBC Holdings and Standard Chartered could face losses of $611 million and $177 million respectively, according to early estimates from analysts at Goldman Sachs. Both have substantial Middle East operations.
In Asia, Japan's Sumitomo Mitsui Financial Group, the country's No. 3 bank, could be exposed to Dubai World's indebted property arm at the cost of several hundred million dollars, according to a person familiar with the matter.
South Korea estimated the country's financial institutions have just $88 million in exposure. Construction firms from Japan, Australia and South Korea behind Dubai's recent development boom also might be on the hook.
Uncertainty over recovery
Among U.S. banks, Citigroup Inc. had $1.9 billion in exposure to the United Arab Emirates as of 2008, according to a JPMorgan research note. But it's unclear how much of that was related to Dubai. Citigroup declined to comment.
Even if most banks could absorb any Dubai-related losses, the emirate's troubles could lead them to reevaluate and scale back lending. That would make it harder for companies to borrow and to help sustain the global recovery after the deepest recession in decades, analysts said.
Equally unsettling for investors was uncertainty over which companies were exposed and how much money they might lose. European banks alone have $87 billion at risk in the emirate.
"It touched investors' sensitive nerves," said Cai Junyi, an analyst for Shanghai Securities. "The world is watching whether that will have any substantial impact ... Dubai World is just like a small window that might reflect another financial tsunami."
Emerging markets in the Middle East and elsewhere have attracted enormous capital amid investor enthusiasm for regions with rapid economic growth. This year, markets in Asia and Latin America have vastly outperformed those in the U.S. and Europe. But Dubai's woes could stall the buying behind the boom, analysts said.
"I think it will make investors realize they need to be more discriminating about emerging markets," said Arjuna Mahendran, head of Asian investment strategy at HSBC Private Bank in Singapore. "In the longer term we have no doubt that things are going to recover."
HSBC declined to comment. Calls to Standard Chartered representatives were not returned.
Among other companies with Dubai ties, South Korean construction firms have about 40 projects there whose remaining work is valued at up to $3 billion. South Korea's government said it expected the problems to have minimal impact.